Most project financiers will agree that a project finance model is one of the most complicated financial models to build. What happens when a project reaches Financial Close? The model, in most cases, then takes on a life of its own when it becomes an operational financial model!
A Financial Close model is a financial model built for the purpose of raising capital and understanding a deal, with the final aim being to reach financial close. This financial model will be used by both equity and debt providers to understand the risks and sensitivities of the project, and how much the project can be geared, in addition to project returns. The model will be used throughout the financial close and hedging process and is also a powerful negotiating tool when used correctly. A Financial Close Model is used expressly for the purposes of achieving ‘Financial Close’.
Once a project reaches ‘Financial Close’, construction and operations start. Debt is drawn down during construction and paid back during operation, and the project earns revenue and incurs expenses. It is during operations that financial covenants and ratios can be measured to assess the project. Crucial for lenders is that covenants are not breached during the debt repayment period.
An effective operational model is also exceptionally useful for project events that may happen during operations, such as refinancing and sell-downs. Indeed, a well-built operational model can be used by the equity holders to effectively negotiate refinancing or additional gearing.
So how does one convert a Financial Close Model into an Operational Model?
Ensure inputs which cannot be changed once Financial Close has been reached are hardcoded. This may include sculpted debt repayments, hedged rates or sensitivities built into the model for running scenarios during the funding process. It should not be possible for future model users to change these cells or any other inputs that have been ’hardcoded’ and agreed to during Financial Close.
Ensure that inputs that do require changes or to be updated during operation (wind data or power generated, sales, traffic etc.) can be changed very easily and the place in which these can be changed can be easily found. Anyone responsible for updating the operational financial model should understand exactly what and where they need to update assumptions with actual figures when updating the operational model.
Have a proper handover process and training to ensure the model builder adequately explains how the model works and what will be changing now that the model is being converted to an operational financial model. In addition, it should be clear what key ratios and outputs equity and debt providers expect to see on an ongoing basis.
Ensure that ratios and covenants are clearly displayed as the bank will be particularly interested in monitoring these.
Ensure that the cashflow waterfall is still functional in the operational financial model- this will be key to ensure that ratios are correctly calculated, and the bank can assess cash flows.
Build in an operational dashboard that will be useful for management reporting. This dashboard will also show when key events can or should occur.
Audit the operational model to give management and the bank’s confidence in the model. While this might seem like overkill, I personally think that auditing a model that will probably (despite everyone’s assumptions) survive the length of the project – be it 17 – 25 years, is extremely worthwhile and an easy decision to make.
Obviously, this is not a comprehensive list. Operationalising a financial close model should take into account all of the intricacies of the specific transaction. That said, following the above list will help to move from a model built for Financial Close, to one that can be used to monitor a project and be decision-useful.
Ultimately – every financial model should be decision-useful, i.e. it should be a tool used for decision making of both an operational and strategic nature. A Financial Close Model that has successfully been transitioned into an Operational Model will be both operationally useful for management report, and strategically important for key project decision making.
Good luck, and happy financial modelling!